Also tested was a four-asset model, with 25% each in large-cap U.S. stock, non-U.S. stock (represented by the MSCI EAFE Index), U.S. bonds and cash. It underperformed compared with the 60/40 model and finished with an ending account balance of $383,280 and an internal rate of return of 4.57% - just slightly ahead of the 50% bond/50% cash retirement portfolio.
The next portfolio was a multiasset portfolio consisting of equal allocations to 12 different asset classes (a concept I explain in my book, 7Twelve: A Diversified Investment Portfolio With a Plan). This model includes 8.33% in each of the following categories: large-cap U.S. stock, mid-cap U.S. stock, small-cap value U.S. stock, developed non-U.S. stock, emerging markets non-U.S. stock, REITs, natural resources, commodities, U.S. bonds, TIPS, non-U.S. bonds and cash. This diversified retirement portfolio was slightly underwater on two occasions (1998 and 2002), but then resurfaced and finished the 15-year period with an ending balance of $774,486, with an internal rate of return of 7.73%.
Finally, I simulated an all-stock portfolio, with a 100% allocation to large-cap U.S. stock (or the S&P 500). A 100% stock allocation is rarely recommended as a retirement portfolio, but I included it to provide a point of reference because the S&P 500 is used so commonly as a performance benchmark. The first two years were terrific, but then it began to falter, and by 2002 it was underwater. The account balance resurfaced for two years (2006 and 2007) only to plunge in 2008. In the end, the account balance was $324,447. Its internal rate of return of 3.93% was even below that of a 50% bond/50% cash retirement portfolio.
This analysis clearly demonstrates that diversification is a valuable portfolio construction guideline for distribution portfolios during the post-retirement years. Said more plainly: Diversification makes just as much sense during the post-retirement period as it does during the preretirement accumulation years.
If the last 15 years are any sort of indicator of the future, building broadly diversified retirement portfolios is prudent, logical and beneficial. Simply diversifying among two asset classes (stocks and bonds) is insufficient. The good news is this: With an ever expanding array of mutual funds and ETFs that represent all manner of asset classes, it's never been easier to build diversified portfolios.
Craig L. Israelsen, Ph.D., a Financial Planning contributing writer in Springville, Utah, is an associate professor at Brigham Young University. He is also the author of 7Twelve: A Diversified Investment Portfolio With a Plan.